Freemium: attributes of an emerging business model

Nicolas Pujol, author

Pujol Enterprises LLC, Kirkland WA
http://nicolaspujol.com; info@nicolaspujol.com
DRAFT v1.1, revised 11 December 2010

Quantity differentiation is the most ancient: product

samples have long been us ed in pre-sales situations,
Origins and types of freemium representing the zero price version of its commercial
complement, the full product. Samples are a form of
An umbrella term for new and old freemium with quantity limitation, in terms of
volume. The digitization of the economy through
commercial practices
media, software and network services has given rise
Freemium is a term increasingly used in commerce to
to another type of quantity limitation: time.
designate a business model using two products or
Nowadays, web services can be activated and
services, or a combination of products and services.
terminated within a defined time period through trial
In such combination, one item is provided at no
programs that serve as demand generation during pre-
charge while a complementary item is sold at a
sales cycles. Variations of the time differentiation
positive price. Unlike what economists call tying, the
concept also gave birth to maturity: beta, immature
free and commercial items are softly connected: the
versions are often made available to a subset of a user
complement is not indispensable. The practice has
population (for example, developers of software
existed for decades, although it carried different
programs) or the entire user base with disclaimers
names and forms. The term Freemium was coined by
that such product is unstable and unsuitable for
venture capitalist Fred Wilson in 2006 and is
general purposes. Other distinctions include
gradually becoming a model that businesses identify
enthusiast versions, which contain new features that
with. Freemium relies on a free version of a product
have not been time tested. In other words, the value
or service, and by design there are complements that
from the asset comes from the quantity of time that it
can take various forms . Commercial transactions
has been used, which reflects the amount of users
happen outside of what is given away. The delta
having tested its reliability. Customers pay for
between what is free and what is paid is called
maturation of time.
product differentiation.
One variant to the time differentiation paradigm
Freemium is sometimes mistaken with two-sided
includes data release. This is particularly relevant for
platforms. In the latter case, a company deals with
time-sensitive data such as financial news and
different groups of customers. Each constitutes a
generally media-related information. In this model,
market side that is statically established. There is no
vendors provide the data at no charge over time, but
transition or conversion from one side to the other. In
release it first to paying customers gaining a time
freemium however, free and paid users may
advantage over free users.
constitute one general group. Each free user can
become a paid user, and vice versa. However, we’ll Feature differentiation separates product functionality
see that even if not a platform, freemium may have and levels of service between a free and commercial
similar attributes to two-sided markets. set of offerings. At the core, one finds either a
product that is limited in functionality (the free core)
Types of freemium
and another that includes advanced features
There are four differentiation strategies: by quantity,
(premium core). From this epicenter, adjunct services
feature, or distribution.
may be added and target either the same user as the
free product or a different one within the

Electronic copy available at: http://ssrn.com/abstract=1718663

organization. Feature differentiation can be
challenging as it requires trade-offs between growing
the free user base and generating revenues. This is
the reflective competition dilemma in a book to be
published early 2011.
Another type of freemium may allow a commercial
model through differentiated distribution and use
cases. The split between free and commercial models
occurs in the way the product or service is
distributed. This scenario is mostly found today in
Figure 1: 13 "free vs. paid" scenarios in freemium (A= free; B=paid)
The nature of freemium is a form of demand
generation. Given such demand generation is attained
through a product or service and not a traditional
advert (banner, catalogue placement, generally, a
message), freemium is often seen as a product
strategy with a zero price, an odd transaction where
the recipient receives a free product without counter
Electronic copy available at: http://ssrn.com/abstract=1718663
packaged software that includes a user license. The
license, open source or commercial, dictates the use
cases where the product may be used at no charge
and those that require a commercial right. Depending
how the end user obtains the product and what she
does with it, it is free or it costs money. For example,
software may be free to use but not to re-distribute or
embed. Alternatively, it may be free for non-
commercial purposes or require a fee-based license if
the end user utilizes it for commercial purpos es.
party, no requirement to purchase now or later.
Viewing the transaction this way would leave the
tangible benefit for the provider ignored: the user
pays for the free good with an alternative currency,
which is mind share. Mind share is the development
of awareness for the provider’s brand and the
consideration for purchase of future commercial
products and services. It is in itself a seed of brand
equity planted in the recipient and not a currency
when the recipient is provided a message, and a
message only. Mind share becomes a currency in the
context of recipients being provided more than a
message i.e. the value of a product or service,
monetarily “free”. It becomes the currency of
exchange. Sales cycles in freemium scenarios
therefore have two steps, representing two discrete
transactions. The free product plays a dual role: first,
that of a product (playing in a market) at a zero price
in step 1, and that of an advert for a related
commercial offering in step 2.

Table 1: comparison of traditional sales cycles with freemium

Pre-sales Transaction

Traditional sales cycle Advertising (banner, ad words, Sale of commercial product or

Freemium sales cycle (step 1)
Freemium sales cycle (step 2)
message) – step 1
Free product or service wins on
basis of zero price, value proposition
and viral marketing
Free product acts as the advert for
related commercial goods
service – step 2
Free product or service is sold at
price of zero. Currency: user’s mind
share.
Sale of commercial product or
service. Currency: money.

Freemium as a multi-sided market

Multi-sided (often simplified as two-sided) markets
represent a business relationship where a company
deals with different groups of customers that are
dependent on one another (Hagiu, 20091 ). This
interdependence between one group and another is
called indirect network effects. The presence of
network effects and the distinct separation of one
group of customers versus another, are two factors
that define multi-sided markets. In academic
literature, two sided markets are often referred to in
the context of platforms. Schmalensee and Evans
(20072 ) list four types of multi-sided platforms:
Software platforms: end customers purchase
computer devices in large part because of the
applications that are available on the device. As a
result, platform companies must court application
developers to work with them while at the same time
promoting and selling their products.
Freemium does not involve a platform to operate.
Furthermore, free users and paying customers belong
to one general category. By these two characteristics,
the model does not fit the standard definition of two-
sided markets.

Exchanges: the platform company puts buyers and
sellers in contact towards a transaction.
Advertiser-supported media: the twentieth century
radio stations, newspapers, televisions and newer
businesses including internet search, making content
available at no charge to users while generating
revenues displaying ads .
Transaction systems, such as credit card companies
dealing with consumers and merchants.
However, a look at the real world reveals a different
reality. We can take the example of open source
software: models in this industry do require distinct
sub-groups of users in order to function. For
example, early adopters and technically savvy users
are often knowledgeable enough to never have to rely
on outside services or tools that facilitate the use of
the products. We can refer to this group, or side, with
the letter A. In return, these free users deliver value
to the provider by testing the product, creating a
brand, and sometimes contribute code or bug reports.

Electronic copy available at: http://ssrn.com/abstract=1718663

A different group of users is more conservative in
nature, and often defined at the business or
commercial segment of the market. This segment that
we can call side B is the one using commercial
services and/or feature upgrades from the free
product.
Sides A and B have distinct demographics, behaviors
and needs. They are sometimes playfully represented
by the photo of a Computer Hacker (a technically
skilled software professional with an early adopter,
trial-and-error bias) and a corporation’s Chief
Financial Officer (pragmatic, more risk averse and
looking for commercial relationships with software
providers). Their commonality is that they both
represent users, unlike platforms where the two
customer groups are distinct by nature.
In addition to being distinct, the two sides of
freemium show interdependence: risk averse
customers value the fact that early adopters have
battle tested the software while providing the vendor
positive brand equity that will help it sustain its
business over time. Conversely, free users benefit
from the presence of commercial customers in the
ecosystem: the latter provide vendors the financial
resources to produce more free software and share
more code. This interdependence mirrors the indirect
network effects seen on platforms.

Figure 2: transactions in freemium

1
Andrei Hagiu: Note on multi -sided platforms, economic foundations and strategy (HBS, 2009)
2
David S. Evans and Richard Schmalensee: The Industrial Organization of Markets with Two -Sided Platforms
(2007), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=987341